Long-term: Price, supply problems

Hembree Brandon | Mar 09, 2001

From predictions of a “golden age of agriculture” to the reality of unprofitable crops and government bailouts, the 1996 Freedom to Farm Act that passed with so much fanfare and optimism has come up short, members of the House Agriculture Committee were told in recent Washington hearings.

“Unfortunately, within two years of the farm bill's passage, we saw our fortunes change,” says committee chairman Larry Combest, R-Texas. “Now, top farm economists are predicting a fourth consecutive year of record-low commodity prices.

“This is the time to move beyond generalities and search for concrete ideas that will improve the economic conditions of agriculture.”

USDA's chief economist, Keith Collins, projected that under current legislation and programs, without supplemental government payments, net cash farm income in 2001 will sink to the lowest level since 1994 and will be some $4 billion below the average of the 1990s.

A report by the Food and Agriculture Policy Research Institute (FAPRI) projects that net farm income over the next two years could drop more than $9 billion, a result of a triple whammy from reduced government payments, rising production costs, and lower prices.

The annual 10-year baseline projections, used in legislative policymaking, point to a decline in net farm income from the present $45.4 billion to $36.3 billion in 2002. That's a whopping $18.7 billion below the $55 billion recorded in 1996, when world grain supplies were low and commodity prices were high. Now, plentiful world supplies continue to keep prices under downward pressure.

The declines projected by FAPRI are based on continuation of the current law and do not assume the supplemental payments made to farmers in each of the last three years. Congress approved $8 billion in emergency aid to U.S. farmers last year and it is expected that supplemental payments will be required this year to keep many of them afloat financially.

Near term crop prices are projected to average 20 percent below 1995-99 levels, while production costs are rising. Expenses for fuel, fertilizer, and other manufactured inputs went up more than 10 percent in 2000 and are expected to show another significant increase this year.

The dilemma confronting agriculture requires some serious analysis as the debate on a new farm bill gets under way, says Daryll E. Ray, professor of agricultural economics and rural economics at the University of Tennessee.

“As an active commodity analyst for over 30 years, my message to you is that we need to decide whether the problems of crop agriculture are short-term aggravations or serious, lifelong ailments,” he told the congressional committee. “Are we talking about the Asian flu or emphysema?

“No decisions about the nature of the new farm bill should be made until we understand the root of the problems in crop agriculture.”

Terming the 1996 farm bill “a policy experiment we have been running over the past five years,” Ray says that legislation “was based on speculation” that:

Export growth, particularly to China, would propel crop agriculture into a new era of prosperity.

Farmers would respond to market signals, producing less when prices declined and more when they increased.

Crop markets would self-correct in a reasonable time, without politically unacceptable devastation to the sector.

“While speculation sometimes generates successes, failures are also common,” Ray says. “Each of these speculated changes in the economic underpinnings of crop agriculture was wrong.

The supply-and-demand characteristics of agriculture “virtually assure there will be little change in total crop acreage or in the quantity demanded as prices fall — even by 40 percent over a four-year period.”

The current supply-demand situation isn't a short-run problem, Ray told the committee.

“Left to itself, agriculture would continue its downward spiral, bankrupting successive farmers on a given piece of land, forcing bank foreclosures, and in general wreaking devastation on all rural areas. It would be a disaster of a magnitude that would be well beyond political acceptability.”

Farm policy based on transition and emergency payments, revenue insurance, farm savings accounts, etc., works best if price and income problems are short-term, Ray says, and if, on average, prices and incomes are “OK.”

“Based on what we know about the characteristics of crop agriculture, there is no reason to believe that prices and incomes would average OK,” he says.

Bruce Gardner, professor of agricultural and resource economics at the University of Maryland, suggested that a two-pronged strategy is needed for farm policy:

One that would assist financially troubled farmers.

A second that would maintain the U.S. position as a world leader in agriculture and food, with an industry of independent commercial farms able to grow freely and flourish economically.

While many farmers “are in deep financial trouble,” Gardner says, their plight is not as extensive as in the 1980s when thousands went out of business.

He cited a 1999 USDA study showing 7.7 percent of U.S. farms to be financially vulnerable or only marginally solvent. “Current market prices of grains, oilseeds, and milk would not justify investment in farming by most producers,” he says.

Yet, in 1998, data show average farm household income of nearly $60,000, compared to about $52,000 for average non-farm households. “This is a remarkable economic achievement,” he says, “given that during most of the 20th century farm household incomes appeared stuck at 60 percent or less of non-farm incomes. Even in the 1910-14 ‘golden age of agriculture,’ farm people did not break this barrier.”

The difference, Gardner notes, is off-farm income, which has “permitted farm households to catch up with the non-farm population in standards of living” and has enabled many small farms to survive.

The 153,000 commercial-size farms earned an average $117,000 in net income, not counting off-farm income, in 1998, he says, and had an average $1.3 million invested in their operations. Their average 6 percent return on capital invested “was not huge, but it appears that as a group they are viable business enterprises under current conditions and levels of government support.”

Gardner told the committee while loan deficiency payments (LDP) result in problems of overproduction, that “is not as costly to our economy as the pre-1995 programs were, with their set-asides of cropland. Those programs, if operational today, would likely result in the idling of 20 million to 30 million acres under annual acreage reduction programs… and a net loss to our economy of $1.4 billion to $2.1 billion annually.”

But, he says, the loan programs “have large budget costs and… are forestalling farm production adjustments to current market conditions. I believe the single most important change that should be made in commodity policy is to reduce loan rates.”

Still, he says, current programs overall are much less costly to the economy than pre-1995 programs.

“Policy should not treat commercial agriculture as a sick sector that has to be permanently propped up,” Gardner says, “and it should not treat commercial farmers as welfare recipients.”

He said current commodity programs “on the whole, are an improvement over those that preceded the FAIR act, in that they do not attempt to micromanage commodity markets or farmers' decisions as much as former programs. But the remaining commodity programs serve little economically-useful purpose from the national economic viewpoint.”

With respect to safety nets and risk management, Gardner says, “a case can possibly be made for assisting farmers with broad-based risk management tools such as revenue insurance or tax-sheltered savings accounts — but these should operate on a commercial basis. They should not subsidize riskier production, as current crop insurance programs do.”

A return to federal supply management and government stocks holding “is the least promising approach,” he says.

USDA chief economist Keith Collins said the U.S. agricultural sector is expected to “continue to recover from the current weak market situation” over the next several years.

“Rising world demand, along with continued progress toward freer trade” are projected to lead to “steady increases in U.S. agricultural exports,” which with increased domestic use should boost farm cash receipts, although “farm income could fall below recent levels during the next few years as gains in cash receipts fail to offset lower government payments” called for in the 1996 farm bill.

“If declining government payments are not offset by rising market income and off-farm income, farm finances may come under stress,” Collins says. “Beyond the next few years, the outlook for the farm sector improves as expanding exports further strengthen farm commodity prices, and increases in farm income and farm asset values help to moderate farm financial stress.”